Dann: What are the main ideas you focus on at the Center for Open Innovation?

Chesbrough: Our focus at the center-- is that companies should make much greater use of external ideas and technologies in their own business and in turn allow unused internal ideas to go outside for others to use in their business. The things we're focused on at this point fall into three main areas. One is business model innovation [the focus of his 2006 work Open Business Models: How to Thrive in the New Innovation Landscape]. The second is management of intellectual property in a world of open innovation. And the third is innovation of services.

Dann: People generally understand licensing a technology or conducting corporate venturing-- but what does it mean to have an open business model?

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Chesbrough: I put forward kind of a six-stage maturity model for business models.

First, you have a pure commodity business model. Then, a second higher stage is a differentiated business model, where you can price to some extent on your value rather than on your cost, but it's difficult to sustain over time. This gives rise to a lot of "one-hit wonders." In the third stage, you can combine both commodity and differentiated elements and segment your market; this lets you participate in some of the volume economics of the commodity business, but also with the margin benefits of differentiation. You can have more flexibility and long-term robustness with this model. In the fourth stage, we begin to move outside and become more open and incorporate external ideas and technologies.

It's at the fifth stage where you take it s step further and are really balancing internal and external sources of innovation along with internal and external channels to the marketplace. So, here, the company is quite capable of capitalizing on ideas wherever they come from and is also deploying them through a variety of paths to market.
You might say, "That sounds pretty great. How could you do any better than that?" But this leads to a sixth stage, which is the best business model stage I can think of -- maybe you can help me think of an even better one, Jeremy -- this is the "platform" innovation model. At this level you have outside companies committing their own capital to invest in support of and alongside your own activities. A quick example of this is Apple, which in recent times has had success with the i-Pod and now the i-Phone. Well, Kleiner Perkins last year launched a dedicated venture capital fund of $100 million called the "i-Fund." So, here is a leading VC fund committing its own capital in support of startups developing things around Apple's activities.

Dann: What are some examples of companies that are really embracing this philosophy?

Chesbrough: Oh, gosh, there's a bunch. I think Procter & Gamble is a very well known example. [CEO] A.G. Laffley just came out with a book this summer called Game-Changer where he writes in some detail about their journey to a much more open model.

Another company I am interested in is Amazon, which not only sells books and a variety of other things directly to their customers, but will also sell things from other companies as well through its website -- and you don't even realize as the customer you're not dealing with Amazon. And now they've created this back office capability called Amazon Web Services where it will rent out its own IT platform for other companies to use in their businesses. So, Amazon embodies being open toward the consumer and being open about its back office activities, fully leveraging its capabilities.

Dann: How do you teach open innovation in the classroom? It seems once you have a class focused on this, students would already know the answer. "Look to outside sources! Look to outside innovations!" How do you give them an appreciation of when to develop internally versus when to go outside?

Chesbrough: That's a good question. I start with the question "How did we used to do this?" and we'll look at Bell Laboratories and XEROX PARC [Palo Alto Research Center], IBM's Watson research labs or the enormous development efforts of the Big 3 American automakers. We'll say, "What's the problem here? What's wrong?" We'll identify some anomalies where companies invent things internally but then find that others profit from them rather than the companies themselves. So, if you think of Bell Labs and the transistor, actually Sony was one of the very first companies to ship a product made with the transistor. If you think of Xerox PARC and the "point and click" computer interface, Apple really capitalized on it even though PARC did the pioneering work.

But we do get to some of the limits of the open model. Can you be open everywhere all the time? If you are, how do you capture a piece of value to sustain yourself over time. This gets us into the concept of business models. And now we see people in their own business models trying to leverage the activities of others. We examine open-source business models where companies are donating to the open-source community freely, but finding other places where they can make money indirectly from their contributions.

Then, we focus on "how does this apply outside the IT domain?" which is where a lot of the research originated. We'll look at pharmaceuticals-- and organizations like OneWorld Health, trying to address third world diseases and need for vaccines. These are big markets that are not well-served by the traditional pharmaceutical industry business model. How could open models help address these things? We look at the role of foundations and how they might use prizes to spur innovation.

We then move on to what I call "innovation intermediaries," who have built businesses helping firms scout for external technologies or help companies "mine" internal technologies that aren't being used, staging them so they can be taken out of the companies for others to use.

Jeremy Dann is a Lecturer in Marketing at UCLA's Anderson School of Management and an innovation consultant and writer. He has been a contributor to several business and technology publications and is the founding editor of "Strategy & Innovation."